Cited: Reuters
The US dollar is taking a beating; there is no doubt about that. Last time it took such a beating was when the country was facing a mounting inflation and the escalating cost of the Vietnam War. The then president, Richard Nixon (Tricky Dick), took the United States off the gold standard on August 15, 1971. The gold standard had been in place since 1944 and Nixon ordered the Federal Reserve to back all dollars in circulation with gold
The move amounted to a made-in-America double-digit devaluation, shocking the country’s foreign creditors.
Deep inside the New York Federal Reserve Bank’s fortress in lower Manhattan, Scott Pardee, then 34, was fielding frantic calls from central bankers around the world. They were demanding the United States cover the foreign exchange risk on their reserves.
“The whole roof came in on us,” recalled Pardee, a former New York Fed staffer who is now an economics professor at Vermont’s Middlebury College. “That is the kind of situation the U.S. doesn’t want to be in.”
Nearly 40 years later, the dollar still dominates world trade. At the height of the financial crisis in 2008, investors fled to the dollar as a temporary safe haven. But the dollar has been falling steadily since 2002, and as the world economy recovered last year, dollar selling resumed, and reviving doubts about how long it could remain the world’s unrivaled reserve currency.
The Greek debt crisis, which has sent investors stampeding back into the U.S. currency, has provided a reprieve. The dollar has gained some 10% against the euro since December. And following the Fed’s decision last week to hike the discount rate it charges banks for emergency loans, the dollar rose even higher as some investors bet it would benefit from the eventual end to the Fed’s post-crisis regime of easy money.
But a number of economists, investors and officials here and abroad interviewed for this story say the longer-term prognosis is far from rosy.
As the United States racks up staggering deficits and the center of economic activity shifts to fast-growing countries such as China and Brazil, these sources fear the United States faces the risk of another devaluation of the dollar. This time in slow motion — but perhaps not as slow as some might think. If the world loses confidence in U.S. policies, “there’d be hell to pay for the dollar,” Pardee said. “Sooner or later, the U.S. is going to have to pay attention to the dollar.”
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French President Nicolas Sarkozy isn’t on anybody’s short list for the Nobel Prize in economics. But at January’s World Economic Forum in Davos Sarkozy proposed, to scattered applause, creating a new version of the Bretton Woods currency accord, which set up the very gold standard that Nixon brought crashing down.
Most economists doubt a return to the gold standard is feasible in today’s interconnected world, with so much capital crossing borders at the click of a mouse.
Yet, as Gian Maria Milesi-Ferretti, a foreign exchange expert at the International Monetary Fund in Washington, put it: “Post-crisis, a lot more things are on the table. It is true among policymakers and in the markets that people are much more willing to look at unconventional proposals and even some proposals that may seem antiquated.”
ACROPOLIS NOW
Some argue the dollar’s recent rally against the euro and yen (it’s up almost 6% against the Japanese currency since December) is less a vote of confidence than a realization that it’s simply the best of a bad bunch.
Per Rasmussen, a retired currency trader who worked at Chase in the late 1970s in London, called it a “reverse beauty pageant” in which investors pick the “least ugly” contestant. Since rising above $1.50 in November, the euro has tumbled more than 10% and was last changing hands around $1.3550, near a nine-month low.
The currency has been battered by doubts about whether Greece and other wobbly euro zone economies can manage the spending cuts needed to rein in out-sized budget deficits. The worries have weakened confidence in the whole concept of European monetary union.
Thomas Kressin, who helps manage PIMCO’s $100 million GIS FX strategy fund, said the euro is in danger of entering into an extended downtrend that takes it as low as $1.22 — which he described as fair value — over the next three to five years.
But the euro’s lurch lower has done nothing to change traders like Axel Merk’s dim view of the dollar’s future.
Based in Palo Alto, California, Merk has been trading for 16 years and is currently president and portfolio manager of Merk Investments, the biggest mutual fund manager dealing exclusively with currencies.
He acknowledges he has had to scramble in his short-term funds to avoid being on the wrong side of the euro’s nosedive. But over the next decade and beyond, Merk said the dollar has nowhere to go but down.
Investors will balk at “reckless U.S. fiscal and monetary policies” and start looking for alternatives to the U.S. currency, he said.
Others might take refuge in commodities. A recent U.S. Securities and Exchange Commission filing showed billionaire investor George Soros’ New York-based firm more than doubled its bet on the price of gold during the fourth quarter.
Merk, whose $550 million Hard Currency Fund is designed to profit from a steady dollar decline, said he believes Washington is banking on a gradual dollar devaluation to shrink its monstrous debt and fuel an export boom to propel the economy.
“Now I am convinced that (U.S. authorities) consider a weaker dollar the solution to many of their problems. But you can’t turn your policies upside down and expect the rest of the world to put up with it forever.”
That view is at odds with the official line from U.S. policymakers. They insist that “a strong dollar is in the U.S. interest,” a phrase repeated so often by former Treasury Secretary Robert Rubin in the 1990s it became his mantra. The person in the job today, Timothy Geithner, has made this mantra his own. Treasury officials, who routinely defer to the Treasury chief as the only authorized spokesman for dollar policy, declined to provide comments for this story.
SHARING THE SPOTLIGHT
What’s clear is that America’s debt-holders aren’t the passive, pliant bunch they used to be. Some of the biggest holders of U.S. dollar assets are also among the fastest growing economies and they are hardly bashful about criticizing U.S. policies, particularly now that the financial crisis has eroded America’s influence and its reputation for sound economic management.
China alone holds $2.3 trillion in foreign exchange reserves, with nearly $800 billion in U.S. Treasury debt. And at a press conference last year, Premier Wen Jiabao did not mince words: “We have lent a massive amount of capital to the United States and of course we are concerned about security of our assets. To speak truthfully, I do indeed have worries.”
Terrence Checki, who has acted as the Federal Reserve Bank of New York’s chief international trouble-shooter for two decades, warns that the U.S. cannot afford to ignore such concerns.
“We are no longer alone as the central axis for the global economy,” he told a gathering of influential bankers and policy-makers during a Foreign Policy Association dinner at New York’s St Regis hotel in December. That, he added, implies “recognizing that our leverage will not be what it once was. We also need to be attentive to the messages we receive, such as rumblings about the dollar and our policies and priorities, even when we disagree with them.”
History suggests that a currency is supplanted the same way Ernest Hemingway said a man goes broke: gradually, then suddenly. In terms of economic might, the United States surpassed Britain in the late 19th century. But it took another 60 years and two world wars to strip sterling of its reserve status.
Even so, some worry time is not on the United States’ side. Emerging markets already account for roughly half of global output and that share is rapidly increasing. In 2003, Goldman Sachs said the size of China’s economy would surpass that of the United States by 2041. Five years later, it revised the forecast to 2027. China is expected to surpass Japan as the world’s second largest economy this year.
All of which would be fine were it not for the fact that the United States continues to live beyond its means. The recent spike in borrowing and spending following the financial crisis is creating a debt burden that, in the word of Moody’s Investors Service, is trending “clearly, continuously upward.”
Continued in “Is US Dollar Doomed? Part 2“
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My Take: I remember one of my high school teachers saying World War III will not be fought with bullets, guns or bombs, but with the dollar. This article seems to be holding true to that statement. I am no economist or expert, but I know that the dollar is the blood of this country and it seems this country is slowly bleeding to death.
I know what they could do! Put on the benefit to hope the country pay off its debts. It’s only fair since the country help them get out of bad spot, don’t you think? Maybe they could get a few movie stars to make an appearance, get choir to sing during intermissions and maybe a comedian to bring everybody spirit of. Of course, they will need to get choir risers so everybody can see them. Don’t forget the seating risers so that the audience can see at this stage properly. I know, this is all a dream.
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